What Now?

What Now?

The debt ceiling ended up being resolved pretty easily. While the more extreme positions on both sides of the aisle seemed unsatisfied with the deal, the larger section of politicians in the middle were perfectly fine with the compromise.

What now? The Treasury should start refunding their Treasury General Account (TGA.) This is expected to involve over $700B of funding over the next three months and over $1.2T through the rest of the year. BofA’s Michael Hartnett believes that globally, we could see almost $1.5T drain from the system over the next 3-4 months. We’ve had a bit of a break in the liquidity drain to start the year, with China and Japan stimulating some and the West responding to banking crises, but that break is likely to be over, shortly. We saw liquidity drains hurt in the past, including last year. Should this time be any different?

I’m not trying to predict the end of the world here, but I also can’t find an example of the TGA refilling and the Fed shrinking their balance sheet at the same time. We don’t need to see downside instantly, though, and it’s not like there’s going to be $1T drain this week. It will all take time. We’ve seen some animal spirits lately. While around here is a pretty logical stopping point, I don’t think you can rule out the possibility of a surge to around 4400 on SPX.

Longer term, I find it hard to imagine a significant liquidity drain won’t have an effect, particularly as investors are so complacent. Additionally, with the potential of a recession on the horizon, patience makes an awful lot of sense, to me. It’s unpleasant getting left behind by AI stocks YTD, but I remember getting left behind by dot com stocks in 2000 and banking stocks in 2007. Patience paid off back then, and this setup strikes me as very similar to those periods.

As I’ve said before, our focus during dangerous times is on capital preservation. Yes, it would have been nice to catch more of the tech move, but we can’t fix the past, particularly not by chasing what’s already run. It would be perfectly normal and reasonable to see a double-digit decline in the market with these conditions, even though most seem to think that’s very unlikely. From here, with VIX at the lowest level since the Covid crisis started and dark skies ahead, caution sure makes sense to me.